The 'Big Four' accountancy firms audit all but one of the UK's FTSE 100 companies and represent 99% of audit fees in the FTSE 350, according to new research. With no sign of change to the market structure, Government intervention becomes a possibility.
The research by economic consultancy Oxera was commissioned jointly by the Department of Trade and Industry (DTI) and the Financial Reporting Council (FRC), the UK's independent regulator for corporate reporting and governance.
The report, published today, does not demand change; but it will be used by the FRC as a basis for taking forward a wider consultation with all stakeholders on the implications that the current market structure has for the efficient and effective operation of the market.
Prior to 1998, people talked of the Big Six. Then Coopers & Lybrand merged with Price Waterhouse to become PricewaterhouseCoopers (PwC), reducing the market to the Big Five. Then Enron imploded and consequently Arthur Andersen dissolved in 2002, leaving the market with the Big Four: Deloitte & Touche, Ernst & Young, KPMG and PwC.
Oxera found that reputation directs FTSE 350 companies to the Big Four, based on differences – real or perceived – with mid-tier firms. Ninety-seven percent of FTSE 350 companies use the Big Four for their audits. They reckon the Big Four are better placed to offer key components of that work: value-added services on top of the audit itself; insurance against catastrophes and reputational risk; and, due to their capacity and international coverage, the technical audit itself.
While the high concentration of work has led to higher audit fees, lower fees seem unlikely to widen the market. Some bargaining on fees takes place during the annual audit firm reappointment process; but in general the focus of audit committee chairs is more on quality (and reputation) than price.
Oxera also found that some UK-listed companies, primarily the financial services firms among the FTSE 100, appear to have no effective choice of auditor in the short term due to high market concentration, auditor independence rules, supply-side constraints, and the need for sector expertise.
Oxera does not expect the market to change. The barriers to entry into the market for FTSE 350 audits are too high for mid-tier firms. Any new entrant would need to overcome perception barriers and demonstrate sector-specific skills, international coverage and high quality staff to win audits. And the loss of a Big Four firm could lead to serious problems for some companies and damage investor confidence.
The FRC says it will evaluate possible measures to reduce "actual and perceived barriers to entry with a view to improving market structure." It is also considering options to reduce the risk of unnecessary failure of a significant supplier of audit services.
Chief Executive of the FRC, Paul Boyle, said: “A well-functioning market for audit services is essential to ensure confidence in corporate reporting and governance. The report from Oxera raises a number of issues about the structure of the audit market in the UK. We look forward to hearing a wide range of views from interested parties in the coming months.”
Trade and Industry Minister Gerry Sutcliffe added: "This analysis provides the Government and FRC with a thorough and thought-provoking analysis of the audit market and its dynamics in the UK."